States' Rights

If you think sales taxes have been around for centuries, you're right. There was actually a consumption tax on cooking oil dating back to the Egyptian Pharaohs. But the first U.S. sales tax wasn't levied until 1930, when Mississippi initiated collections. Today, 45 states and the District of Columbia impose sales taxes on the retail prices of certain goods and property.

"Sales taxes exist because states realized a number of years ago that they need a reliable and recurring source of revenue," says Nicholas Nesi of BDO Seidman LLP in New York. "A sales tax is how they run the government, how they promote social good, and how they manage responsibilities such as fire, police, education and social needs. Sales taxes fit these revenue goals extremely well."

But not all sales taxes are created equal. According to the Federation of Tax Administrators (FTA), the combined local and state sales tax rate in Hawaii is 4 percent, but the combined rate in Arkansas is 11.5 percent. One reason for the disparity is that local governments use sales taxes to raise revenue for community needs such as transportation issues. "New York's sales tax has three components: a state rate, a county rate, and in counties close to New York City, there's a metropolitan commuter transportation tax," says Michael Buxbaum, CPA, of www.nysalestax.com, a company that helps businesses with New York State sales and use tax issues.

In addition to the local variable, each state decides its own exemptions. While a sales tax is a consumption tax, it is also regressive; as an individual's income rises, the percentage of sales tax paid against the individual's income decreases. So exemptions are sometimes allowed to benefit society. For example, according to the FTA, California exempts food purchases from sales taxes to help lower income people buy necessary goods. And only Illinois imposes a sales tax (1 percent) on prescription drugs.

Currently, five states--Alaska, Delaware, Montana, New Hampshire and Oregon--have no sales tax. But that doesn't mean they don't manage to get the money they need. "Washington state has a sales tax, but doesn't have an income tax. But Oregon, which has no sales tax, has an income tax," says Chris Edwards, director of tax policy at the Cato Institute in Washington, D.C.

But does this mean your client can buy a car in Delaware and then drive it home to Virginia to avoid sales taxes? "The 'use tax' is the flip side of the sales tax. There's a compensating use tax when a person or individual business entity resides in a state with sales tax, but purchases an item in a state with no sales tax," says Buxbaum. While tracking items like groceries is basically impossible, most states have a system in place for items requiring registration, such as cars or boats.

For instance, a consumer can't buy a car in Delaware and register it in Virginia until the use tax is paid. "If you can't register the car, you're not allowed to drive the car," Nesi points out.

On items that aren't tracked, it's your client's obligation to self-assess and remit the tax to the state using the client's annual tax return. The current system's self-policing is only one of the reasons experts believe sales tax statutes will be redefined.

According to Nesi, a higher percentage of the GNP now comes from the provision of services, and not from the sales of products. "The states will have their revenue bases eaten into; that's a cause for concern and something states will be addressing in the next few years. Some states may want to modify sales tax statutes to include a greater percentage of services in their definition of tax base," says Nesi.

Enter the Streamlined Sales Tax Project (SSTP), an effort by state governments with local and private sector input to simplify and modernize collection and administration of sales and use taxes. However, "The SSTP only affects member states," says Josie Henneke, director of state and local tax services at Hull & Knarr LLP in Greenwood, Ind. "People who are a part of SSTP are genuinely interested in simplifying the sales taxes."

But not everyone is convinced this is a good thing. "I like states to compete against each other. The SSTP would eliminate interstate tax competition. This competition provides pressure on politicians to keep the rates down," says Edwards. While 13 states have joined, some larger states, like New York and California, are not yet on board.

The SSTP also opens the door to an Internet sales tax, since it decreases the seller's burden of tracking various rates among the states. The Center for Business and Economic Research at the University of Tennessee estimates that lost tax revenue in 2006 could approximate $26.5 billion; and by 2008, it could approach $33.7 billion. States like their independence, but given the numbers involved, more may be tempted to join the SSTP.

Financial planners should keep an eye on this over the next few years. If Internet commerce becomes subject to sales tax, online companies become relatively less attractive as investments for your clients.

Beverly Harzog, a freelance writer and former CPA, lives in Alpharetta, Ga. She has written for American Fitness, Health, Bankrate.com, and Today's Family.